Jonathan Portes of the National Institute of Economic and Social Research (NIESR) and Mark Littlewood of the Institute of Economic Affairs (IEA) represent opposing sides in the ongoing debate over economic policy – namely the ‘demand-side’ pro-stimulus brigade and their ‘supply-side’ pro-austerity opponents. In a fascinating exchange for Prospect, Portes and Littlewood score points off one another, but do not provide a convincing account of their own. Let’s begin with Littlewood’s opening salvo:
“The doomsayers were wrong. George Osborne’s efforts to get the UK’s chronic budget deficit under control have not crashed the economy. It now appears a modest level of growth has returned to the economy and private sector employment has remained impressively robust. “This is not what the deficit-deniers predicted. At the outset, they enormously overstated the cuts to government expenditure, with the enthusiastic collaboration of parts of the media. In real terms, the coalition is reducing spending by a little less than 1 per cent per annum.”
All of this is true, but then so is the following from Portes:
“When the government announced its fiscal consolidation plan in June 2010, it predicted that, by now, the economy would be about 7 per cent larger, driven by a sharp rise in business investment and an improvement in the current account balance… But GDP has grown at less than a third of that rate, business investment has fallen and the current account deficit has worsened…”
The British economy is a rich source of inconvenient truths for both sides in this argument – and thus they both have some explaining to do.
Littlewood blames the slow recovery on the failure of the Government to cut further and faster. He also points his finger at “swathes of stifling regulation”. But if these factors where so crucial a couple of years ago, why aren’t they today? It’s not as if the government has changed course between then and now. Furthermore, private sector employment recovered well right from the outset – suggesting that the labour market is not in need of radical deregulation (i.e. stripping protections from the already hard-pressed British worker).
Portes too has some difficulty in fitting his theories to the facts of the British recovery. If austerity was enough to halt the recovery in 2011, why isn’t it still doing the same in 2013? After all, austerity is still with us and will continue to be for the foreseeable future. However, he’s almost on to something when he makes the following assertion:
“…[The Government’s] policy was supposed to boost confidence, and spur private sector investment to fill the gap, business was understandably reluctant to invest in a climate of uncertainty about demand.”
This is the interpretation you’d expect from a demand-side economist. But what if it wasn’t demand that the country was so uncertain about? What if it were something much more fundamental – like the basic soundness of the economy? Following the banking and Eurozone crises, people weren’t just pessimistic – they were frightened, horrified even. What they needed wasn’t a demand-side spending spree or a dose of supply-side shock therapy, but the calm assurance of a return to economic sanity. Nor was there any short-cut to restoring confidence, rather proof was required that the Government was committed to the long, slow, hard slog of fiscal retrenchment. In this respect there’s a half-nod to George Osborne from Mark Littlewood:
“The Chancellor has been cautious with the public finances, to the irritation of those of us who would have pursued more radical surgery to tackle the obesity of the state sector. His strategy is to win the race slowly and steadily.”
Now, at last, we can see the practical benefits of this approach. What the Government’s economic policy lacks though is a theoretical underpinning. That won’t matter to most people, but to the extent that theory guides future policy it would be helpful to have one that fits the facts.